Protectionism and Free Trade

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1. Introduction

Today's markets are mostly global and therefore influenced by many factors, which also lead to massive financial crises, like in the actual situation, or even to times of an economic boom. After centuries of market development, they emerged into global markets through technological advancement, improved communication and transportation possibilities and political decisions like the liberalisation of markets. Simultaneous to the globalisation process and the worldwide spanning of the markets, the influence of the national government as well as the influence of supranational institutions (e.g. The World Trade Organisation, WTO) arose. Specific market rules were defined in the General Agreement on Tariffs and Trade (GATT) and other regulations. As much advantages the globalisation brings, there are also disadvantages, mainly in the form of governmental barriers to restrain trades through methods such as tariffs on imported goods, quota arrangements and other governmental regulations. These measures which can be outlined as protectionism are one of the main impacts on global trade and also the contrast to free trade, in which governmental barriers are kept as low as possible. Another factor that is playing a bigger role in an advanced internationalized work of a company is the effect of foreign exchange. The author will describe all the mentioned points and apply them to a case study which will be the recent trade dispute between the USA and China, concerning imports of tyres to the United States as well as imports of car parts and chicken to China. Furthermore, the author will describe related business strategies, which are the absolute advantage theory, the comparative advantage theory and the game theory. All these theories are based on the idea of free trade. To analyze free trade and protectionism you need to see both in a contrast with arguments for and against each of both ideas.

2. Protectionism and Free Trade

The term protectionism basically describes measures of countries to hamper imports into their territory. The competition gets tougher for companies that try to export into this specific country and they can not use any comparative advantages. Countries mostly try to protect specific branches or companies, when they are not competitive on the global market and to support an undisturbed development of a branch which is trying to get competitive. Most popular measures that belong to protectionism are governmental policies concerning tariffs, quotas and other regulations. There are many different forms of these regulations, of which the most important should be described in general now. Tariffs are determined on imported goods to raise their price on the domestic market. It also may be determined on exported goods to hold domestic companies from exporting their goods and rather sell in in the local market, but export tariffs are applied very rarely. Quotas reduce the quantity of imported goods through the arrangement of a maximum of goods in a given time that can be imported. This measure also raises the price of these goods because of their shortage on the market. Other regulations could include direct and export subsidies. Direct subsidies are given to companies to improve their competitive situation. Export subsidies are used by governments to increase the amount of exports by giving the exporting company a certain percentage of the value of their exporting goods. The strongest type of protectionism is the trade embargo where a government cuts the import quota down to zero respectively banning the product from the domestic market.

Free Trade is the complete contrary of protectionism and therefore a policy free of governmental trade barriers or even trade without governmental interference. There are several free trade agreements in the world, which mostly which mostly include trading goods without taxes or tariffs as well as free access to markets and market information. This also contains the absence of subsidies of each the importing and the exporting country.

Both forms, either free trade or the protectionism, do have their advantages just as well as disadvantages. In an environment of free trade, a company can use their cost advantage, which is based on better technology and a more efficient use of resources (e.g. lower production costs) in comparison to their global competitors. The company and the country it's situated in can specialise on the production of a particular good through using their comparative advantage. Assuming that every country specialises on what it can do best, there would be an ideal allocation of goods throughout the world. Improved allocation leads to more working places and an exportdriven economic growth. Another advantage of free trade are sinking prices on the global market and a transfer of technology which provides innovation. Free trade avoids support of inefficient and declining branches, which could lead to a punctual loss or working places, but is an advantage in a long term. The growing interdependencies between the countries in an environment of free trade are leading to a better cooperation and understanding of different cultures and finally to a better stability and peace. But sometimes, a country has to control their imports and exports and their balance of payments, which leads to several arguments in favour of the protectionism. Supporters of protectionism argue that large countries can improve their terms of trade through trade barriers. Terms of trade describes the index of the price a country receives for its export product divided through the price it pays for importing it. However, a country has to count on retaliation measures, if it tries to improve their terms of trade with trade barriers. Another important argument for protectionism is to help young industries, which are still developing, to grow without being threatened by stronger companies from other countries. Many countries accomplish protectionism to secure jobs, a specific level of income and obviate migrate of companies to cheaper countries. They were many supporters of each free trade and protectionism, e.g. Adam Smith statet that the market would regulate itself, if there is no governmental interference. This theory is also known as the “invisible hand”. On the other hand, John Maynard Keynes claimed that private sector decisions often lead to inefficient outcomes and an unhealthy market situation and therefore there would be a need of governmental influence.

Past and Future of Trade

In the past, there were different applied methods of protectionism. An example for this would be the mercantilism. In this epoch, the powerful nations of Europe captured the rest of the world and made their own colonies. Mercantilism is an economic theory which holds that the prosperity of a nation depends upon its supply of capital, which is best increased through a positive balance of payments. Mercantilism suggests that the ruling government should advance these goals by playing a protectionist role in the economy, by encouraging exports and discouraging imports, especially through the use of tariffs. It was at its height in the 17th and 18th century. Out of this economic theory evolved the neomercantilism which some countries applied or still apply in modern times. Neomercantilism is a term used to describe a policy regime which encourages exports, discourages imports, controls capital movement and centralises currency decisions in the hands of a central government. It is called "neo" because of the change in emphasis from classical mercantilism on military development, to economic development. It also accepted a greater level of price fixing based on market. Nowadays, different forms of protectionism are frequently observed, which can also be assigned to the neomercantilism. According to the Chad P. Bown “The global economic crisis has been accompanied by an increase in the global use of import-restricting trade remedies as a protectionist response.” (The Global Resort to Antidumping, Safeguards, and other Trade Remedies amidst the Economic Crisis, 2009, p. 20) Targets of new protectionistic measures are mostly situated in developing countries, as well as the initiators of Antidumping and Safeguard measures. The most frequent user, according to this research paper is India, while most actions are used against China's exporters. Although the recent use, mainly triggered by the world financial crisis, is not alarming there are trends suggesting that future use may increase, due to retaliation. Another reason for a growing use of Antidumping, countervailing and safeguard actions by GATT, is the fact that these measures replaced the countries own measures of quantitative restrictions, licensing requirements and foreign exchange controls, that were used up to the late 1950s. According to The World Trade Report 2009 of the WTO, “the more frequent use of AD/CVD/safeguard actions by an increasing number of WTO members today may constitute the substitution of one set of instruments of flexibility for another.” (Bachetta, M. et al, World Trade Report 2009, WTO, p. 131) Although there are many cases of trade disputes in the latest time, there is one that attracts special attention. The US Government approved new 35 % import duties on Chinese-made tyres, which were the first American tariffs of this kind against a Chinese product since their joining of the WTO eight years ago.

3. Case Study

The basic idea of Free Trade lies in the fact that a country and the businesses operating in it, may specialise on what they do best, allowing a higher performance as well as a perfect allocation of goods throughout the world. In spite of all the benefits this trade philosophy brings with it, a country would not allow an uncontrolled flow of goods across their borders. In fact, many countries are using protectionistic measures to guard their businesses and industries from global competitors. This recent trend should be explained and analysed in the following chapters on the example of the trade disputes between the USA and the People's Republic of China.

3.1 Background of Chinese-American Trade

Since the collapse of the Sovjet Union in 1991, the United States of America are the world's only superpower to stay. Their lead in economy and military technique seems to be uncatchable. Also, the American culture proceeds to spread throughout the world. However, in the southeast of Asia there is a new competitor growing up: The people's republic of China. China is to be considered as the only power of the world that could compete against the USA in terms of economy, as well as politically and military. Due to this fact, the future of the global system will depend essentially on the Chinese-American relation. The trade between these two countries has a long history. It originated in the late 18th century, when the USA started to import tea from China. In Modern times both are trading mostly machinery and electrical equipment as well as many other things (tables ).

However, the USA is importing much more in worth than they are importing, which is leading to a massive trade deficit.

Reaching its highest level in 2008, America imported goods to the amount of 337.772 Billion US-Dollars, while importing goods to the amount of only 69.732 Billion US-Dollars, with a deficit of 268.039 Billion US-Dollars.

3.2 Trade Disputes/Case Study

Schilderung einiger Handelskonflikte aus verschiedenen Gründen, Einsatz der WTO, IMF, GATT usw. Aktueller Fall USA - China, Gründe, Fakten, Wechselkursrolle, evtl. Einfluss der Regierungen.


Evaluate the risks, consequences/implications and outcomes of such negotiations/ decisions, linked to these international disputes, for both countries and international trading companies.